New Insider Trading Regulations: Are You Guilty?

The US has no specific, articulated law against insider trading. It relies instead on general SEC provisions and judicial opinions of over the last 5 decades. India explicitly prohibited insider trading in 1992. And now, 23 years later, it has re-written the regulation to expand the definition of insider, provide perpetual insiders a trading opportunity and legitimize the communication of inside information for purposes of investment due diligence. This new regulation will come into effect in May and will better equip SEBI to go after insider traders. But have we gone from too little power in the hands of SEBI to too much power? To answer that CNBC-TV18’s Menaka Doshi speaks to Tata Group’s General Counsel Bharat Vasani; Amarchand’s Managing Partner Cyril Shroff and Senior Advocate Amit Desai.

Doshi: What do you make of this regulation in its entirety.. before we do deep dive into specific provisions - the big picture view?

Shroff: The fact that we have revamped the insider trading code is a welcome development because one of the scourges of our market has been that there has been rampant insider trading. There were a number of loopholes in the prior version of the regulation which needed to be corrected. The heart of this regulation is in the right place, the intention is very clear to make the market more secure and to bring the wrong doers to book. Having said that, in terms of how the regulation has actually come out after a long process of discussion, is that it achieves some of these objectives but there are a vast number of unintended consequences which are going to have a profound impact on deal making. They might have a profound impact on even innocent people who might be unfortunately caught in how this could work and may in some respects have actually created unintended defences which SEBI may not have thought of how broad they are and we can in the later part of this panel discuss this. It is too early to judge whether this is going to achieve the desired objective. It started off on the right journey but whether it reaches the destination or not, I have my doubts.

Doshi: You want to add to that quickly?

Vasani: When you have appointed an expert committee with eminent people, they have taken a trouble of drafting the regulations and then after almost a year without giving any justification or rationale of why you are departing from this recommendation, even the new regulations which in my opinion could have been much better, it is a disappointment on that count that they should have at least explained why some of the recommendations were disregarded.

There is a very fundamental shift made now which will be tough for the corporates and large corporate houses is that now communicating UPSI unpublished price sensitive information itself is made an offence. When you are dealing with 560 thousand employees and large number of officials, mere communication- until now in 2002 when the SEBI amended the insider trading regulations they brought out a press release and they said very categorically that communicating UPSI is not an offense it is only trading based on UPSI is an offence. Now they have made it abundantly clear that just communicating, even if not trading and dealing has happened itself, is an offence.

Doshi: The 1992 Regulations do say that no insider shall communicate, council or procure directly or indirectly any UPSI to any person who while in possession of such UPSI shall not deal in securities. It is sort of a twisted bar on communication?

Vasani: Dealing was a very critical part- if you see the SEBI press release of 2002 it categorically said that unless you deal with it, communicating is not an offense. Now for the first time they have made communicating UPSI an offence. By expanding the scope of the connected person, they have created several situations which only time will tell us to how it is going to play out but it is too wide a definition to be regulated. In fact SEBI itself will find it too difficult to regulate this kind of definition.

Doshi: You want to add quickly- a big take away from this?

Desai: Whilst you see that there is some good which has come out of this regulation and as Cyril Shroff rightly mentioned that you have got the heart in the right place to try and deal with the scourges, the issues that the regulators are going to face in the context of trying to investigate and discharge the burdens that they have taken up on themselves in this regulation are going to be extremely onerous on the Department. At the end of the day I wonder whether they would be very successful in actually trying to ensure that the scourge that they started out to deal with they will effectively be able to handle with this kind of a regulation.

Doshi: I saw that the efforts to rewrite this was also to give SEBI more power- combined with the new powers they have under the SEBI Act to go after insider traders - more effectively and I will tell you why.

As you just heard the Prohibition of Insider Trading Regulations, 2015 increases the restrictions on communication of unpublished price sensitive information and prohibits an insider from trading in securities when in possession of unpublished price sensitive information. Now, an insider means any person who is connected or is in possession of unpublished price sensitive information or UPSI. This definition of insider is similar to the 1992 definition but the definition of connected has changed dramatically. Earlier a connected person included a director, officer, employee or those with a professional or business relation with the company which may give them access to UPSI. The new regulation adds to that list anyone who is associated with the company not just via contract or fiduciary duty or employment but also via frequent communication with the company’s officers. The list of deemed connected persons is similar to the old regulation except that it alters relative to immediate relative including spouse and financially dependant parent, siblings or children. So, will this expanded definition of connected person and hence insider help SEBI cast a wider net?

INSIDER TRADING REGSMain Offences1992No insider shall communicate/counsel/procure unpublished price sensitive information…-Except when ‘required in the ordinary course of business, or profession or employment, or under any law’

2015No insider shall communicate/provide/allow access/procure/cause the communication of any unpublished price sensitive information, relating to a company or securities… - Except where such communication is in furtherance of legitimate purposes, performance of duties or discharge of legal obligations

INSIDER TRADING REGSMain Offences

1992No insider shall either on his own behalf or on behalf of any other person, deal in securities of a company listed on any stock exchange when in possession of any unpublished price sensitive information;2015No insider shall trade in securities that are listed or proposed to be listed on a stock exchange when in possession of unpublished price sensitive information

INSIDER TRADING REGS‘Insider’ Definition

1992- Connected to the company or deemed to have been connected… and is reasonably expected to have access to UPSI- Has received or had access to UPSI

2015- A connected person- In possession of having access to UPSI

INSIDER TRADING REGS‘Connected Person’ Definition

1992- Director, deemed DirectorOROfficer, Employee or has professional/business relation with company- May reasonably be expected to have access to UPSI

2015- Associated with a company in any capacity, including by reason of frequent communicationORContractual, fiduciary or employment relationship- That allows access to UPSI

(Immediate Relative: means spouse and includes financially dependent parent, sibling, child of such person or spouse)

Shroff: I think the answer is yes because it is a qualitative expansion of the definition by virtue of the frequency and the intensity of the relationship or connection with company. It certainly broadens the net but whether something is positive or not I think we should judge it and evaluate it with reference to the object that is being sought to be achieved finally. If the object is only to expand the net, I would give it a tick and say it achieves that. Finally what is the impact of that in terms of how you will be able to bring a charge, a legitimate charge and be able to establish it is the later part of the conversation.

Doshi: There have been cases previously where people known to be close to group heads were accused of insider trades and they just claimed that they had no official position and therefore they were not within the definition of connected person under the earlier regulations. This new definition of connected - by saying that even if you have frequent communications with someone who is in the position of power in company you become a connected person- plugs that loophole which gives SEBI more power; doesn’t it?

Vasani: They have migrated from position based insider to…(Interrupted)

Doshi: Association based (Interrupted)

Vasani: Absolutely; but while they have widened the net they have left the big hole inside still.

Doshi: Which is?

Vasani: Which is that they had rightly recommended that public servants would be covered. All of us are aware that companies file their advance tax payments, they make advance tax payments. They file Foreign Investment Promotion Board (FIPB) application for new projects. There are public servants and SEBI officials in case of many other transactions, they become privy to unpublished price sensitive information. There is evidence that there is a trading based on those information.

Doshi: But they come within this connected person?

Shroff: It covers person.

Vasani: Definition of public servant which was there as a part of Sodhi's recommendation and the fact there is specifically the connected person definition included including public servant that has been taken out.

Doshi: I suspect it is more for reason of being politically correct but not necessarily being legally opposed to the concept?

Shroff: The definition of person is broad enough to pick up all of that.

Desai: The problem that we are going to face is if you look at the definition, the expanded definition of connected persons, they have been cautious to try and exclude the public servant from this. If you look at it, the qualifications that have been put whilst it is qualitatively wider, the qualification that they have put are who are directly or indirectly in any capacity including by a frequent communication. Now a public servant may not be in frequent communication with a connected person by any contractual, fiduciary or employment relationship the public servant is in none of those or a director, officer or an employee of the company or holds any position including a professional or business relationship between himself and the company temporary allows etc. so what you have effectively done is you have excluded the public servant by process of this interpretation.

Doshi: In which case he would fall under the second criteria to make him an insider which is that he would be in procession of UPSI? He may not be a connected person which is a very wide definition but by having that information if he knew something that the market place did not know and he traded on the basis of that he would still be an insider trader? They do not escape the net; they just do not get the specific mention that was there in the Committee report.

Vasani: They will use it in their defence that the objective was not to cover the public servant and that is why this was removed.

Doshi: Can you use a committee report in your defence in a court of law?

Vasani: It has been used in the past in Supreme Court for so many cases. Anyways so that was one of the things which I thought was missed out in the definition of connected person. I am very worried about this frequent communication. You can have frequent communication with a person which is completely unconnected with company’s functioning to a friend or someone else and now you are virtually making that person a connected person and god forbid if that person were to trade during a period when some merger and acquisition (M&A) transaction was to happen, he has to prove his innocence now. As you know there is a reversal of burden of proof. It would be a tough one for the person just because he is constant communication with some official of the company.

Desai: Therefore the example that you gave is that whilst the attempt has been made to reduce the number of relatives by bringing in the aspect of immediate relative and those who are financially dependants. What happens with their relatives, frequent communication? So how do you determine because the question is that whether the communication is relatable to the question of insider information.

Vasani: I will give you an example. I have so many friends with whom I discuss Hindi film music, and we are frequently in communication and unfortunately if that person was to trade in any of the Tata Securities and there was a transaction going on a that time, on the call data record which SEBI has power now…(Interrupted)

Doshi: But surely they do not mean for frequent social communication; surely they mean frequent official communication… (Interrupted).

Vasani: There is no reason to assume that that they do not mean that.

Vasani: If you see SEBI now has acquired power to get call data record. So, they will figure out that there is so much of communication with this person.

Doshi: But they do not know exactly what you are talking about? They do not know that you are talking about Kishore Kumar and not Tata Steel acquisition.

Vasani: Absolutely!

Doshi: The definition of connected person and insider has been expanded to cast a wider net and the burden of proof has also shifted. It is now up to the connected person to prove that he is not connected with the company and hence does not have access to unpublished price sensitive information (UPSI). Whereas in the case of those not connected but charged with having traded while in possession of UPSI, SEBI has to prove the possession of UPSI. Does this shift in burden of proof make it tougher for those accused to defend themselves? Amit Desai says on the contrary, SEBI has provided the accused with a jumbo defence.

INSIDER TRADING REGS

- Wider definition of ‘connected person’ in 2015 regulations vs 1992 regulations- There is also a shift in the burden of proof- 2015: ‘In the case of connected persons the onus of establishing, that they were not in possession of unpublished price sensitive information, shall be on such connected persons and in other cases, the onus would be on the Board’

Desai: In fact it makes it that much more easy to defend themselves.

Doshi: Why are you saying that?

Desai: Because what has happened and that is a dramatic change. So far as an insider who was not a connected person is concerned, the burden of proving that he is an insider in possession of the price sensitive information, is on SEBI.

Doshi: Which was the case earlier as well?

Desai: No, the defence that they have now brought in which is in the proviso 4 (1), is that the insider is entitled to prove his innocence through a set of circumstances. Those circumstances which are not actually defined in the Act would suggest that if there is an absence of a mens rea – so you didn't do it for the purpose of committing the fraud on the capital market which is really the underlying intent of this particular regulation.

You did it for example; you needed for medical expenses, so you sold some shares for medical expenses. You needed for a marriage in the family. Then those are circumstances which are extenuating circumstances, they are defences which are now available to such an insider in relation to this..(interrupted)

Doshi: On what basis are you saying that?

Shroff: Even a bona fide corporate purpose may be brought in.

Doshi: So explain to me how you have reached this conclusion?

Desai: So, if you look at 4(1) and the proviso to 4(1), which says that provided that the insider may prove his innocence by demonstrating the circumstances including the following, so there are a set of inclusive or illustrated defences which are there but when you talk about proving his innocence, the innocence is only in the context of what the regulation intended to achieve. So what you did was just saying, I didn't intend to commit the offence of insider trading.

INSIDER TRADING REGSDefences?

20154. (1) No insider shall trade in securities that are listed or proposed to be listed on a stock exchange when in possession of unpublished price sensitive information: Provided that the insider may prove his innocence by demonstrating the circumstances including the following…

- Inter-se transfer between promoters, both sides having the UPSI- In case of non-individual insider – person making the trade different from person with UPSI etc…

Doshi: But if you look at the outs or the innocence demonstrations that they have offered here, they are very strict. For instance they have given you the illustration of, you can prove your innocence by demonstrating that the transaction is an off market inter-se transaction between promoters, both sides of whom were in possession the UPSI or if you were a non-individual insider, they have said you can prove your innocence through a series of steps which show that the individual who traded was not the same as the individual who had the UPSI or if there were Chinese walls between the two.Shroff: These are not illustration of innocence.

Menaka: These are illustrations. The seriousness of this illustration…(Interrupted)

Shroff: These are not illustration of innocence. They are just specific carve outs.

Doshi: So wouldn't any out that anybody uses in this defence…(Interrupted)

Shroff: It's a mens rea defence.

Doshi: No but any out would have to be as serious as this, wouldn't it? Can they use the out that someone in my family fell ill, they would have to show that that person was critically ill but someone in my family fell ill and I sold on the basis of that and if that is the reason why you sold, then isn't that not insider trading?

Shroff: But again these are human circumstances. It could even be, I needed to exit from this business to liquidate it and reinvest it in a good legitimate other purpose.

Doshi: That is not innocence?

Shroff: Why is that not innocence? It's a valid corporate purpose.

Doshi: That's not innocence

Shroff: So long as it is not fraud on the market, everything else is innocence.

Doshi: So you're saying that if you were a connected person who had UPSI and you could demonstrate that you sold for this legitimate corporate reason of wanting to use your capital elsewhere then you would be able to use that as a valid defence and SEBI would not be able to win in a case of this nature?

Shroff: On the law that stands today, yes.

Desai: That's right and that is something we actually tested in a matter of Rakesh Agarwal, which was about 10 or 12 years ago where the facts of the case were that it was actually for a larger corporate purpose. He was bringing in a 51 percent investor into the company; he was about to make an open offer. He found that he was not in a position to actually garner adequate shares for offering his 20 percent into the open offer. He then went into market, bought and put those shares into the open offer in order to ensure that the company actually survived. All stakeholders benefitted from that.

Doshi: He won?

Desai: He ultimately succeeded. It was in SAT and SEBI actually had taken that matter to the Supreme Court and ultimately it got settled. So there was no final ….(Interrupted)

Shroff: The last word on the subject is he won.

Desai: The last word on SAT is he won.

Doshi: So essentially what you are saying is that what SEBI may have gained by expanding the definition of connected person, it has lost by allowing for this one out, this one line which says that you can prove your innocence

Shroff: In terms of bringing in qualitative mens rea defence; yes.

Vasani: It's a very big out.

Desai: It's a very big out.

Doshi: So now let me come back to your concern. You said that you were very concerned that even frequent communication could get you into trouble. If you were to do this to the connected person's definition, which is expand it so that SEBI has more powers, then don't you think its only fair that the regulator has done what it has done which is that given you several defences as well.

Vasani: I am happy with the out; absolutely. All of us are very happy with the out.

Doshi: So, don't the two get balanced to make it a fairer regulation?

Shroff: It is a bit of a blunt weapon over a larger number of people.

Vasani: But I don't know whether it's done with the intention to give the out or has it come out this way. I don't know because there is no debate, no discussion. Until now the doctrine was of strict liability

Doshi: There are some notes.

Vasani: There is a doctrine of strict liability; in fact that's another part. Some notes are there but Sodhi committee had very categorically stated that the note should be treated as an integral part of the regulations; that part has been deleted.

Shroff: The person who has traded in securities, has been in possession of UPSI, his trade will be presumed to have been motivated.

Vasani: Yes, there is a note.

Shroff: The reasons for which he trades or the purpose for which he applies the proceeds are not intended to be relevant for determining whether the person has violated the regulation.

Desai: So, they exclude that mens rea defence by saying the reasons are not relevant …. (Interrupted)

Shroff: The last sentence says, once established, we are open to the insider to prove his innocence by demonstrating the circumstances mentioned in the proviso.

INSIDER TRADING REGSDefences?2015‘…The reasons for which he trades or the purposes to which he applies the proceeds of the transactions are not intended to be relevant for determining whether a person has violated the regulation. He traded when in possession of unpublished price sensitive information is what would need to be demonstrated at the outset to bring a charge. Once this is established, it would be open to the insider to prove his innocence by demonstrating the circumstances mentioned in the proviso, failing which he would have violated the prohibition’

Desai: But that's when the reasons come in again.

Shroff: No, it means rea is back.

Desai: That's right.

Vasani: Mens rea is absolutely back which was not the case hitherto. It was a doctrine of strict liability

Shroff: It is not only back but it has been reiterated by the note.

Doshi: It has been removed by the note and then reiterated by the note.

Shroff: So the last word is that it is reiterated.

Doshi: The note in one part says reasons for which he trades or the purposes to which he applies are not intended to be relevant. Then its says its open to the insider to prove his innocence by demonstrating the circumstances mentioned in the proviso failing which he would have violated the prohibition.

Shroff: The last sentence confirms what we are saying.

Desai: And that is why the regulator was right in saying that the notes will not be relevant for the purpose of interpretation.

Doshi: Because they are confusing notes as opposed to being simplifying ones.

Shroff: I have a big issue with the use of notes as a sort of a legislative or a regulatory tool in this especially where in some cases it actually contradicts. This is one example, there are several examples.

Doshi: So, what have we got here? We've got a more expanded definition of connected persons that allows SEBI to go after a lot of people that were slipping through the cracks.

Shroff: Which is a good thing.

Doshi: We've also got now a bunch of new defences that these people could use to show legitimate reasons for the same.

Shroff: You've got a jumbo defence which you can stretch in whichever way you like.

Doshi: But is it all bad because if they had done only one part of this which is expanded the definition of connected persons, then it would have seemed very unfair without giving people defences. So now they've said we'll give you both?

Shroff: I go back to my original example of the journey and the destination.

Doshi: But they have given you both, so isn't that actually good? Isn't that fair?

Shroff: Is it going to serve the purpose of removing the scourge, I don't know.

Desai: I would look at it from two points of view here. If you look at it from point of view of dealing with transactions, protecting the capital markets etc, its not. If you look at it from the point of view of an insider who has actually taken advantage of the regulation, it's a great out for him. So ultimately, did you achieve the object that you set out because some of these regulations which come in, necessarily have to come in with a sense of strict liability because you have to achieve a larger objective in this process

Doshi: If they would have come in with a strict liability, if these defences were not provided for, you would be arguing the other way round saying how can you tighten the screws on connected persons in this fashion without offering any defences. This is not an authoritarian State.

Desai: If you wear the hat of a defence lawyer, then of course it’s fabulous.

Doshi: If you wear the hat of SEBI's counsel?

Desai: But if you wear the hat of a regulator who's trying to achieve and ensure that this scourge in the market and today what is happening in India is well known to the regulator, then you would normally at this stage not give this out.

Shroff: Or you would give specific outs.

Desai: Or you would give specific outs and in fact in many of the legislation outside, there are very specific outs.

Doshi: But how many outs can you list? This kind of capital reallocation is an impossible out to list. You can list medical emergencies in a family but how many outs can you list? Human minds will come up with all kinds of inventions.

Vasani: But we are all very happy.

Among the many new definitions, is the definition of trading that replaces dealing in securities. Trading now includes dealing to align itself with the words used in the SEBI Act - that is all fine. But the accompanying explanatory note says, the definition of trading now also includes activities such as pledging when in possession of unpublished price sensitive information.

INSIDER TRADING REGSDealing vs Trading

1992“dealing in securities” means an act of subscribing, buying, selling or agreeing to subscribe, buy, sell or deal in any securities…

2015"trading" means and includes subscribing, buying, selling, dealing, or agreeing to subscribe, buy, sell, deal in any securities…Explanatory Note says - SEBI Act uses ‘dealing in securities’, hence “trading” definition included dealing- Intended to curb activities such as ‘pledging’ when in possession of UPSI

Vasani: The way dealing has been expanded in the note includes pledge of shares, has a huge profound impact on financing. People do more over regularly (interrupted...)

Shroff: I do not know whether the bankers in the country have seen this. They will be jumping off their seats when they see this.

Vasani: Absolutely, they do it all the time; pledge the shares of the company listed as the security for getting loans from the banks and how the entire sector is going to get impacted if you were to put all the UPSIs which you have in public domain before you can pledge the shares.

Shroff: I agree with you.

Doshi: But if you pledged while in possession of unpublished price sensitive information isn’t that in some sense also insider trading?

Shroff: No, when you look at a financing transaction, put yourself in position of a bank or non banking financial companies (NBFC) who is lending money against shares, is simply concerned with the value of the security based on whatever is the price discovery in the market. Now to add to it this level of unpublished price sensitive information as something which would contaminate a financing transaction is completely going beyond a scope of what this is meant to cover.

Vasani: They have not thought through to the consequences and the profound impact; an impact analysis has not been done.

Shroff: I have a problem with it because actually the regulation, the words of the regulation are fine, I do not have an issue with it. It is the note which complicates it because it is the note which brings the word pledge which ordinarily would never have the (interrupted...)

Doshi: Pledge is not in the actual definition of trading.

Shroff: It is not because pledge is not dealing, you are not dealing on a proprietary basis; you are only taking security.

Desai: So, unless we go back to the question that we just discussed about the out that did the regulator intend that whilst there is a prohibition and it included in the case of a pledge because if you look at Reg 4 again, that you shall not trade in securities and pledging is a trading in securities then the out is your innocence, that you deal it for a legitimate corporate purpose or legitimate business purpose, namely to finance your business. So is that an out? It could be an out but the problem that I face is that there will be situations where regulator will keep coming after these organizations and insiders and multi-litigation and it is extremely difficult.

Doshi: Not necessarily, because I will tell you what, if you go to a well known bank or a well known NBFC they are not going to extend money to you on the basis of the shares that you pledge to them unless they see what the legitimate purpose is. So, I don’t think every pledging transaction is going to come under the scrutiny of SEBI?

Shroff: It might have been meant to bring in promoter financing but this does not have that effect, it may even apply to a case where the loan is lent to a company for his project based on diligence, in the course of that diligence which every lender will do, they will come into possession of confidential information and pledge of the promoters shares will get picked up in this.

Desai: Let me ask you a different question that came up actually in the Lever case, whether a company is an insider of itself? You remember that issue?

Shroff: Yes.

Desai: Look at the definition of insider here. So, if a company is going in and seeking finance from a bank and it has to pledge some of it assets or whatever it is and there may be also shares, then the company itself is a perpetual insider.

Shroff: Yes

Doshi: That would fall under this.

Shroff: There should be a clarification that should come out which should say ignore all notes if they are inconsistent with the Section, if they are inconsistent with the rule.

Doshi: The notes are supposed to explain the role, not create inconsistencies.

Shroff: But they are expanding the Rule or actually sometimes contradicting the Rule.

Doshi: So, this is the serious pain point that SEBI needs to address, the second one I wanted to bring up is, are you clear on what is UPSI?

The other big change is in the definition of Unpublished Price Sensitive Information or UPSI. The earlier definition said UPSI was information related directly or indirectly to the company, not published by the company and which if published is likely to materially affect the price of its securities. The new definition says UPSI is information relating to the company or its securities that is generally not available, which upon becoming generally available is likely to materially affect the price of its securities. Now, generally available information is defined as information that is accessible to the public on a non-discriminatory basis. The accompanying note uses disclosures to stock exchanges as an illustration but not a limiting one.

INSIDER TRADING REGS‘UPSI’ definition

1992- Information related to the company- Not published by the company

2015- Information related to company or its securities- That is generally not available

"generally available information" means information that is accessible to the public on a non-discriminatory basisDisclosures to a stock exchange offered as an illustration

Shroff: Suppose there is a whole series of news articles or TV shows which run (interrupted...)

Doshi: Would that make it generally.. (Interrupted)

Shroff: So long as it is non-discriminatory and it is available to the public.

Doshi: So that shift is a big shift because still now it had to be a Stock Exchange.Shroff: Now the question could be that if it is now available on an English channel but not a Hindi channel

Vasani: This was the shift which happened in 2002 when they realized that based on Levers case itself that they needed to say that only when company has released the information, it is available. So, they went to pre-2002 situation by bringing it in a way that now anything which is in the market place and generally available would be regarded as..(Interrupted)

Shroff: They have gone back to the Lever 1992

Vasani; Pre 2002 situation.

Doshi: That is what I thought was a big shift, so three big shifts there.

Shroff: Because in that case the argument was that this information about the merger of those two companies was being speculated about in the media every single day and therefore it was generally available and you could rely upon that. I think the new definition of generally available information gets us to exactly that.

Doshi: Now would not an article on some not very well known website but a website that anybody or everybody can read and therefore is accessible to everybody non-discriminatory?

Shroff: I am sure unless if we are defending somebody and that was the case he would definitely argue that as a defense for sure.

Doshi: So that is what I am saying, so that is where my fear came in. The moment you take it away from being a stock exchange disclosure, you open it up into being a lot more.

Desai: The important qualitative term here is ‘generally available’ and when you actually take this example that you gave, that if it is in some non descript newspaper in some corner of the country and then you can come back and argue and say that it was generally available it becomes the question of fact and it will be possible for the regulators to say that, that should not be treated as generally available...(Interrupted)

Shroff: No, because the word generally is only part of the definition; it is not part of the explanation.

Desai: I will tell you what will happen otherwise and that is where I think the courts will have to interpret this. You can have a device where somebody might actually plant a small little article somewhere in some obscure blog somewhere and then say generally available, so that would become the question of fact.

Shroff: The test is not generally available. The test is that it is accessible to the public or a non-discriminatory...(Interrupted)

Desai: Yes, but the question is that if it is in on a blog then it becomes accessible to the public.

Shroff: There is no test of availability prescribed over here.

Desai: That is right, that is not generally available which upon becoming generally available is likely to material affect.

Doshi: Yes, but generally available information means information that is accessible to the public on a non discriminatory basis. If it is a website or some non-descript paper or somewhere in the corner of the country, but actually the paper is generally available to all of us on a non discriminatory basis - any of us could want to read it, so that would fit this. Just on the basis of that defense, you would slip through?

Desai: It depends on how the courts looking at the totality of the facts and circumstances, looks at the nature of transactions, the size of the transaction, the timing in the transaction, the people involved in the transaction, there will be a whole lot of other facts. In that context, of course if this in some non-descript blogs somewhere which is never accessed probably you will find on the hits that only ten people go on that blog.

Shroff: No, you will have to prove malafides.

Desai: But that is where the burden on the regulator becomes a little heavier to establish that there is a device but otherwise it is easy to argue that this is on a non-discriminatory basis because it is available on a blog.

The new regulations make communication of UPSI an offence except in two cases:One, in connection with a transaction accompanied by an open offer and where the board of directors is of informed opinion that that transaction is in the best interest of the company. Two, if the transaction is not accompanied by an open offer then the UPSI is to be made publically available at least two trading days before the transaction is effected.

INSIDER TRADING REGSDue Diligence

Communication of UPSI permitted1. In connection with transaction accompanied by open offerBoard of informed opinion that transaction is in best interest of the company

2. If transaction not accompanied by open offerUPSI to be made generally available 2 trading days prior to transaction

Shroff: You had an absolute defense under the old regulation that if you are going to make an open offer and you come into position of UPSI safe harbour, you are home. But they have added a condition over here that, the giving of the information must be authorized based on an informed opinion by the Board, that is a board of the company. Now when you do a deal actually what happens when you are stitching together and mergers & acquisition (M&A) transaction it is ordinarily the management which cooks the deal and then eventually then takes it up to the board. It can vary on circumstance but that is 8 out 10 cases, management cooks the deal and then takes it for approval to the Board.

What this implies is that the board has to pre authorise the carrying out of the diligence before the diligence is carried out. So you have to firstly go to the board twice. The reality of many boards in India is that if you go with price sensitive transaction to the board for authorizing diligence at an early stage of the transaction, the chances of leakage are really high. So you are going to have corporate India leaking like a sieve.

Doshi: You don’t trust your own board?

Shroff: I am talking of a reality.

Doshi: If you cannot trust your own board, no regulation in the world can work.

Vasani: There is a further practical difficulty here. If the management goes to the board at a very early stage, the board will not be in a position to establish, and particularly independent directors will be able to conclude that the transaction is in the best interest of the company at this stage. So is SEBI going to second guess the commercial wisdom of the board whether the transaction is in the best interest of the company?

So, at this stage the board may be completely not ready to form that opinion and I am telling you sitting on the boards, many a times when a transaction come at very primitive stage and then sub committee of the board is appointed to go into the details of the transactions. As Cyril rightly pointed out it is the management team which is driving it. Board and the independent directors have a very broad 35,000-40,000 feet altitude of the transaction.

Shroff: You bring the cooked deal to the board; you do not bring the recipe to the board.

Doshi: The cooked deal would involve the investor getting access to unpublished price sensitive information before the board has any idea of whether the deal is cooked or not? I am asking you, is that the process of how M&A works?

Vasani: How is board going to opine that it is in the best interest of the company at such an early stage?

Shroff: Two things- informed opinion front end of the transaction- huge issue on confidentiality and it is going to seriously affect how deals are done. The second part is coming to a conclusion that transaction is in the best interest of the company. What if it is the completely secondary transaction as it is very often is. Why should the board form a view on whether selling by the promoter or a majority shareholder to somebody is in the best interest of the company when a competitive offer is still possible.

Doshi: If it is secondary transaction involving the promoter, why should the investor get any more access to unpublished price sensitive information which the other investor do not get.

Shroff: That is a fair point in which case you are saying that in case of a change of control transaction in a major listed company where an incoming investors or foreign investors is going to invest billions of dollars in a company- even if it is a purely secondary transaction - you are telling Mr Investor that you shall not do a due diligence because you have to not only do the diligence…(Interrupted)

Doshi: You are not allowed to due diligence so far anyways.

Shroff: Who is going to do it, which dollar is going to come?

Doshi: Anyways it was not allowed till now. Now there are saying we will allow.

Shroff: It was allowed. It was allowed with an open offer.

Doshi: It was illegitimate, you weren’t allowed to do due diligence, right?

Shroff: We were not allowed to do a diligence but if you had an open offer out it was allowed to do, it was allowed to be done. Now the board has to pre authorise it and conclude that it is in the best interest of the company. Why should the board form a view as to whether sale by the founder or promoter, or major shareholder from X to Y is in the best interest of the company because Z can still come and make competitive offer.

Vasani: Independent directors are already very concerned with what the responsibilities cast upon them under the Companies Act and now if insider trading regulations are going to cast an additional responsibility to come to a view that the transaction is in the best interest of the company trust me…(Interrupted)

Doshi: The very first one is a deal killer according to you?

Shroff: It is a deal dampener for sure, and then we will all find ways around it.

Vasani: Cyril, practicality - two days before you are going to announce..(Interrupted)

Shroff: That’s the second where there is no open offer.

Doshi: I thought that is where you will have the real problem?

Shroff: I have a problem on both.

Doshi: The second one seems to be a little difficult - how do you make it practical to disclose information?

Shroff: We will be the only country in the world where we will have a requirement that before a confidential deal is signed, you have to put it out in the public domain two days before you do.

Doshi: You do not have to put the deal out but put the UPSI out and I am supposing that in itself is ringing an alarm bell.

Vasani: Which is effectively everything is out in open.

Shroff: You have to effectively put the deal out.

Doshi: Or you have work your timelines in such fashion where you put the UPSI out but many weeks in advance of the deal getting closed so that nobody is suspicious.

Shroff: So what are you encouraging then, are you encouraging the people to game the system?

Doshi: No. You are saying that information should be available. In the case of an open offer, retail shareholders get an exit. So therefore you getting access to UPSI being an unfair situation is mitigated in some fashion. In the case where there is no open offer nobody else is getting an exit and therefore benefiting from that price discovery.

Shroff: The distinction about information about the deal and the unpublished price sensitive information is a very thin distinction.

Doshi: Mr Desai?

Desai: This is a matter of great concern because in any deal making, as I mentioned to you earlier, very often a deal has to be done on the basis of an average market price for the previous few weeks. You disclose the UPSI two days in advance - it changes the market dynamics, it changes the entire deal structure. Second, the other question would be that when do you make the disclosure of the deal itself. Because what you are saying you do not have to make the disclosure of the deal, you have to make the disclosure of the UPSI.

Under the Listing Agreement if this has to be done two days before the proposed transaction, the Exchanges are going to say that the deal was complete; you had a duty of disclosure so far as the deal is concerned. The existence of the deal also has to be disclosed at that point of time because you are going to have that situation so far as the listing agreement is concerned.

Doshi: I thought legitimatizing the communication of UPSI in the cases of investment related due diligence was actually one of the good things that this code does or this new set of insider trading regulations does because all this time due diligence was illegitimate so to speak?

Vasani: Good intentions but the way they have drafted it is made deals almost completely impractical. There are many such unintended things. One classic thing I will point out is that they used to use the definition that whatever terms which have been used in these regulations but are not defined here you can use the Companies Act definitions. They used the definition of listed company which is not defined here. Under the new Companies Act, ‘listed companies’ means unlisted companies whose debt securities are listed and it would be subject to the entire discipline of the new regulations I do not think this was intended.

Doshi: So if you are a holding company with listed debt but you are an unlisted holding company - as in your equity is not listed - you would still be subject to insider trading. But what is wrong with that if there could be insider trading that took place even with debt securities. They are only simply saying whatever the security - if there is a market place for the security and other investors for the security - we have to protect them from insider trading.

Shroff: But there also only if you are talking about listed debt securities. However the effect of what Bharat is saying is that once you become a listed company because of this and even your shares which are unlisted will get covered under this.

Doshi: Will the equity shares get covered if only your debt is listed?

Shroff: Securities of a listed company, it is a listed company.

Doshi: How can you in an unlisted company have unlisted equity situation have insider trading.

Shroff: This point has already been lost in the Companies Act because in the Companies Act also, private companies are covered by that.

Vasani: So that is a problem because they used the definition under the Companies Act; it is unintended consequence which I do not think they have thought through.

Like in the US, India too has now introduced the concept of trading plans affording a perpetual insider like a CEO or a CFO the opportunity to buy or sell his company shares in a predetermined fashion. The conditions include a six month cooling off period before the trading plan can be activated, maintain the closed period around financial results, a duration of at least 12 months and details regarding the value of trades or the number of securities to be traded along with the nature of the trade and the trading intervals or the trading dates. Curiously the regulations also say that a trading plan cannot commence till the UPSI with the insider is made generally available.

INSIDER TRADING REGSTrading Plans

‘Provided that the implementation of the trading plan shall not be commenced if any unpublished price sensitive information in possession of the insider at the time of formulation of the plan has not become generally available at the time of the commencement of implementation and in such event the compliance officer shall confirm that the commencement ought to be deferred until such unpublished price sensitive information becomes generally available information…’

Shroff: The concept of a trading plan is a good inclusion but the way it has come out, I don't think that even one person is going to use it.

Doshi: Why is that?

Shroff: There are number of reasons but one reason is the fact that once you have announced a trading plan, then you are required to commit to it and that you will in fact perform the trading plan on the dates that you say; regardless of any change in circumstance. That is point number one. Point number two is that there is an intellectual flaw in the fact that you having announced a trading plan, if you still have UPSI, you would be disentitled to implement your trading plan. The whole purpose of a trading plan is to actually ring fence yourself from possession of UPSI. So, if UPSI is still going to contaminate your decision to implement the trading plan, then what's the point?

Vasani: Absolutely. The very objective was that there are people who will be perpetually in possession of UPSI, so you said that no, if you are in possession of UPSI, you can't implement the trading plan. So there is contradiction in the term itself.

Doshi: They are saying you have to push your trading plan till you have disseminated the UPSI.

Vasani: But I will still have a UPSI continuously because I am supposed to be a person who is perpetually in possession of UPSI.

Shroff: So it's like saying you are a perpetual insider. So I am giving you this avenue of a trading plan which you not only must implement but if you still have UPSI you can't implement it. So, it's a double negative.

Doshi: Aren't they saying maybe UPSI which is slightly more urgent of nature? This is for argument sake.

Vasani: The five conditions which are annexed to the trading plan, I will assure you, not a single transaction will happen according to trading plan.

Doshi: Nobody will be able to use these trading plans?

Shroff: The closest thing that comes to what you are saying is a proviso to sub regulation four and whatever that Section is- it says implementation of the trading plan shall not be commenced if UPSI in possession of the insider at the time of formulation of the plan has not become generally available. To take an example, if you know some mega deal is going to be done with reference to this company and this information is continuing with you, you shall not do it but this is almost always the case that you have such type of (interrupted…)

Doshi: You're not always in the middle of a deal or in the middle or an asset sale.

Shroff: So it is only short term UPSI, it allows you an out for short term UPSI but for something which is more structural and strategic… (Interrupted)

Doshi: It's not written in there and I understand if it's not written in there- there is no point all of us speculating because you can't use it.

Shroff: If you want to hang somebody on this, you'll always find something which is in the mind of that perpetual insider which you can… (Interrupted)

Doshi: So nobody will use the trading plan because they will always be fearful of the fact that… (Interrupted)

Shroff: I can't think of any one of my clients using this unless this is changed.

Vasani: I don't; think. We don't believe that…(Interrupted)

Doshi: And you will not be able to defend anybody who uses this trading plan.

Desai: Extremely difficult.

Doshi: We have covered broadly some of the salient features of these new regulations - expanded definition of connected person, a shift in the burden of proof, several more defenses therefore.

Shroff: One jumbo defense.

Deoshi: One jumbo defense as you have called it, some definitional issues that continue mostly with what is a listed company as Mr Vasani spoke about, the issue with UPSI and what is generally available and not generally available, due diligence which is supposed to be a good opportunity that these new regulations offer which all three of you say will actually just be deal killers and then finally trading plans which were also supposed to be the other big good opportunity that these regulations offered which you say nobody will use. At the end of all of this, do we have a regulation that makes it easier for the regulator to go after the real crooks? Is this an improvement on 1992?

Vasani: I think the time will tell; I would not be able to prejudge this right now. I would say that perhaps some unintended consequences of some of the things which are drafted now, in two years time it will realize. This Code is in for a significant revision within two years.

Shroff: My guess is that the judiciary will have to really evolve principles around this to achieve the real intent. I do not think it is achieved by the language of this. The regulator will of course do their bit according to how they understand the law but SAT and the courts I think will have to really restore the balance on this.

Desai; I think that is going to be a little difficult because ultimately courts can only interpret the regulation and when the context of interpreting the regulation, the jumbo defense that is available becomes the question of fact. You cannot take away the fact that this defense is very much in the regulation now. Every time the regulator will have to have a heavy head burden to try and discharge to show it was a case of insider. Whilst my view is there will be a lot of files that might open up, you may not get adequate relief at the end of the day.